Breakup and Default Risks in the Eurozone

Abstract

Since the burst of the sovereign debt crisis, investors perceive the concrete possibility of a breakup of the Eurozone. We exploit CDS quotes for contracts denominated in different currencies and default clauses to estimate the network of breakup and default risk spillovers in the Eurozone isolating the relevant factors with shrinkage estimation techniques. We find that most Eurozone countries are exposed to economically large redenomination risk spillovers, with the effects stronger at shorter maturities. Redenomination shocks to one country, Italy, spillover on the redenomination and default risks of most other Eurozone countries.

Keywords: redenomination risk, CoVaR, elastic net, LASSO

JEL Classification: G10, C31, C45, C58